December 31, 2004

Two Economists Debate The Future

Economists John Irons (ARGMAX) and Andrew Samwick (Vox Baby) debate the year ahead in the (free) online version of yesterday's the Wall Street Journal. Nice discussion -- take a look, and take notes. You're invited to add your two cents here.

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The Final Labor Market Reports Of The Year

The number of Americans filing initial unemployment claims unexpectedly fell last week to 326,000, evidence the job market may be strengthening heading into the New Year.

Initial jobless claims dropped 5,000 in the week that ended Dec. 25 from 331,000 a week earlier, the Labor Department said today in Washington. Claims have averaged 343,000 a week this year compared with 402,000 in 2003.

The economy probably created 175,000 jobs in December following a lower-than-expected gain of 112,000 in November, based on the median economist estimate ahead of next week's Labor Department report.

The article recalls a report earlier this month reinforcing a view that the jobs picture continues to improve.

The outlook for hiring in the first three months of 2005 has improved from the same period last year, according to survey by Manpower Inc., the world's No. 2 supplier of temporary staff by revenue. Twenty-four percent of the 16,000 employers polled intend to increase their staffs from January through March, compared with 20 percent in the first quarter of 2004, the report, issued earlier this month, showed.

The Conference Board’s Help-Wanted Advertising Index – a key barometer of America's job market – dipped one point in November. The Index now stands at 36. It was 38 one year ago.

In the last three months, help-wanted advertising declined in six of the nine regions across the U.S. Largest declines occurred in the East North Central (-7.5%) and Mountain (-7.2%) regions. Help-wanted advertising increased in the Pacific (3.4%), East South Central (1.2%) and Middle Atlantic (0.8%) regions.

Says Conference Board Economist Ken Goldstein: “Job growth continues to be sluggish, despite periodic reports that some companies are planning to add workers in the months ahead,” says Conference Board Economist Ken Goldstein, a specialist in the labor markets. “This is reflected in the Conference Board’s Leading Economic Index, which has declined in five of the last six months, and by dips in consumer confidence. The widely-awaited turnaround in job growth has yet to arrive.”

Well, maybe. As suggested by the latest data here and here, the "dips in consumer confidence" are not so obvious. And the help-wanted index is itself is a somewhat controversial indicator. But since I'm trying to help out the pessimists, a sympathetic overview can be found in this Slate article, by Daniel Gross.

There's an inverse relationship between unemployment and job vacancies, known as the Beveridge Curve, after the British economist who described it. The curve thus predicts that periods of comparatively low-volume advertising would coincide with high unemployment, and periods of comparatively high-volume advertising would coincide with low unemployment. (This paper has a good description and representation of the Beveridge Curve.)

The Help-Wanted Index shows that's pretty much been the case.The index fell from 100 in 1987 to the low 60s in 1991 and 1992—the depths of the last recession and jobless recovery—and then rose throughout the mid-1990s as payrolls swelled. But in the late 1990s, the neat Beveridge Curve began to get sloppy...

The Help-Wanted Index may have lost its utility as an absolute gauge. The number of help-wanted ads in newspapers has declined, so it will be hard to reach the '87 figure even in good times. But as a relative barometer, it remains as valuable as ever. When help-wanted ads rise, it takes a few weeks for people to respond, have interviews, and then get hired. That makes it one of the best leading indicators of employment we've got. Until the Help-Wanted Index perks up, don't expect payrolls to grow.

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December 28, 2004

Consumers End The Year Happy

The Conference Board’s Consumer Confidence Index, which had been on the decline since August, rebounded in December. The Index now stands at 102.3 (1985=100), up from 92.6 in November. The Expectations Index rose to 99.9 from 90.2. The Present Situation Index increased to 105.9 from 96.3...

“The continuing economic expansion, combined with job growth, has consumers ending the year on a high note,” says Lynn Franco, Director of The Conference Board’s Consumer Research Center. “The most significant contributor to the rebound in confidence has been the overall improvement in current conditions over the past twelve months. And consumers’ outlook suggests that the economy will continue to expand in the first half of the new year.”

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The number one reason for Argentina's financial and economic stabilization is its belated conversion to fiscal discipline -- or what in the old days might have been called a conservative fiscal policy. Why no hyper-inflation after Argentina's default? The government matched revenues and expenditures, avoiding the need to print money. Hardly radical.

... the government has not ran an expansionary fiscal policy after its default. The initial impetus for Argentina's recovery came from the devaluation, which led to a surge in export revenues (measured in local currency terms), not government policies to spur consumption. Government spending initially had to fall to match falling revenue.

The strongest indictment of the IMF is that an Argentine government that explicitly defines its policy in opposition to the IMF has adopted a far more conservative fiscal stance than any Argentina government that embraced the IMF in the 1990s.

Brad goes on to further critique the IMF strategy and generally cast some doubt on the wisdom of fixed exchange rate policies (by dollarization, or otherwise). Read this one too.

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The reporter (Timothy Egan) clearly has a view that the subsidy system is not adequately helping small and medium-sized farms. He even marshals bad statistics to support his case. Consider the next paragraph:

But because nearly 70 percent of the subsidies go to the top 10 percent of agricultural producers, the recent prosperity is not seen or felt among many small to medium-size growers who keep the struggling counties of the Great Plains alive...

Using the article's own statistics, Samwick does a quick calculation.

So if we have 2.1 million farms, the top 10 percent would be 210,000. But it only takes 150,000 of them to get to the 70 percent of production (assuming these "major food crops" are analogous to the "agricultural producers" above). So this means that even though the top 10 percent produce more than 70 percent of the crops, they only get 70 percent of the subsidies. I don't believe that the article provides any evidence that the subsidies are distributed in accord with anything other than total production. It may be true--but the article hasn't shown it.

Of course, both Vox Baby and the Times article raise questions about the design of a policy that has agricultural subsidies growing at multiples of the rate of GDP growth at a time when farm incomes are at record levels. Read the whole post.

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The problem with farm subsidies is everything about their implementation since the 1980s. The feds used to be the marginal buyer of commodities below a certain price. That gave farmers a guaranteed price so they could borrow seed money safely. It cost the feds little money, since they then re-sold the commodities later, usually for prices almost as high as or higher than what they paid. In the 80s and 90s, they changed the system. Now they pay a subsidy to the farmer. It costs the feds huge dollars. But the farmers don't even end up as rich as before, as the market price per bushel of corn, for example, has gone down so much that the subsidy doesn't even get the farmer as much money as he used to get from the guaranteed price.

The whole system is a huge indirect transfer of federal money to the commodity buyers -- ADM, Cargill, McDonalds, etc.

Duhhhhhh, if Farmer A has revenues of $100,000 and net income of $10,000, and Farmer B has revenues of $1,000,000 and net income of $100,000, and each gets a government subsidy of, say, 50% of net income, well, it sure looks to me like rich Farmer B is getting quite a lot richer than poor Farmer A.

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Me: "The key is the phrase 'percentage tax reductions...' One would like to think that health care spending would be measured in more absolute and egalitarian terms."

Altig: "Whether policy ought to be more "egalitarian" is not the sort of thing that economists can speak to with any degree of authority -- our training gives us absolutely no special status for making value judgments."

If my comments were normative I would agree, but they were not intended to be; Economists mean something very specific when they call a tax change 'progressive' and the persistent practice of the current administration and its adherents of mis-labling regressive tax cuts as 'percentage-wise progressive' is disingenuous.

Our disagreement revolves around the statement that "Economists mean something very specific when they call a tax change 'progressive.'" I thought the issue was largely closed in a classic article appearing in the 1948 edition of The Journal of Political Economy, Richard Musgrave and Tun Thin:

... the concept of "increased" or "decreased" [income-tax] progression is ambiguous. In fact, the results depend entirely on how the degree of progression is measured.

Musgrave and Thin go on to identify four possible measures of progressivity. One of those measures holds that a tax policy is progressive if the tax rate rises with income (a property usually referred to as marginal rate progression). This is exactly the situation O'Neill describes in his numerical example.

A tax cut of $150 for someone making $20,000 represents an income tax cut of 10% ($150/$1480). A smaller percentage tax cut of 5% to someone making $1,000,000 amounts to around $16,000 in dollar terms.

O'Neill does not like this definition of progressivity.

The tax cuts for low income families are large percentage-wise not because the numerator (the tax cut) is large, but because the denominator (their current income tax) is small.

Conflating "greatest help to those most in need" with "the highest percentage tax cuts go to the lowest income Americans" might make sense in a world where people paid for goods and services in 'percentages', but the fact is that Americans buy things with dollars. The distributional consequences of tax changes should bemeasured in kind.

I repeat: A-OK. Adam has every right to argue that the "distributional consequences of tax changes should be measured in kind." But the phrase should be is, here, a decidedly normative position. It is fine to disagree, but it seems to me that the concept of progressivity used by the advocates of the administration's policy is entirely standard. It does no service to the debate to characterize it as dishonest.

Having said that, I repeat again: The Lowest Deep post on this subject is an articulate exposition of a view contrary to the Bush proposal, and it does highlight important facts about the distributional consequences of that proposal. It is worth reading for that reason.

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December 26, 2004

Can U.S. Monetary Policy Be Improved?

In this article, we consider a related issue of whether the FOMC policy framework is sound or, alternatively, it was rescued by good luck. In particular, we ask, Do the current policy procedures of the FOMC lead to too much risk of a bad inflation outcome? We argue that they do, and we then propose a type of inflation targeting to contain the risk.

Stern and Miller go beyond the case made by many -- in this discussion by Ben Bernanke, or this one by Don Kohn, for example -- that inflation targeting can enhance an otherwise successful policy, arguing instead that Fed policymakers may have been more lucky than good.

For some time, the United States has experienced a fairly steady, low rate of inflation. However, some investigators attribute a majority of this apparent monetary policy success to surprisingly strong growth in productivity and to inexpensive imports stemming from weak foreign economies. If monetary policy played a relatively minor role, it also follows that monetary policy could have erred on the side of ease and that those errors could have been covered by favorable outcomes for productivity and foreign trade. Thus, the appropriateness of FOMC procedures cannot be judged solely on the recent record with respect to inflation.

Much of the article is spent discussing the case for maintaining the rate of inflation somewhere in the vicinity of zero, and against smoothing fluctuations in real GDP. In fact, Stern and Miller would only begrudgingly concede a role for "leaning against the wind."

We have argued that the economy operates best over time when the inflation rate is within a few percentage points above or below zero. So, as long as countercyclical policy does not push inflation outside of this range, we do not believe it will do much harm.

Inflation targeting it is, then, but the authors are relatively agnostic on what form it takes.

The mechanism we prefer is a form of inflation targeting. Although two methods of achieving this end have been proposed, we believe under best practices,there is little difference between the two. One method is adoption of a nominal anchor, and the other is inflation-expectations targeting.

Each method requires the establishment of a range for a specified variable. If the variable is within its range, policy is free to stabilize output. However, policy is constrained to not let the variable move outside its range. For nominal anchoring, the variable is an observed nominal variable, such as a measure of money. For inflation- expectations targeting, the variable is a prediction of inflation over some multiyear horizon.

Under best practices, a nominal anchor should have a stable long-term relationship with inflation. Ideally,the anchor would provide policymakers with a reliable signal: if the anchor stays within its range, then inflation down the road will stay within its desired range. Policymakers then could attend to smoothing the real economy as long as the anchor was within its range.

Note that Stern and Miller focus on targets that are indicators of future inflation. My sense is that this might differentiate their proposal from other inflation-target schemes, which generally express targets in terms of a direct inflation measure, reserving indicator variables as a basis for policy adjustments and communications policy.

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As Long As We Are Talking About The Current Account...

This Economic Commentary offers a hitchhiker’s guide to the U.S. current account problem for those who want to follow along, but are not inclined to take the wheel. I show how foreigners finance our propensity to import, stopping long enough to make the connection between our budget and current account deficits. I explain why growing current account deficits and expanding inflows of foreign savings are not indefinitely sustainable, and why big deficits imply big corrections. Throughout the trip, however, I emphasize that we simply have no basis for determining when, how fast, or how jarring any adjustment might be. Those who claim a definitive word on that topic may just be spinning their wheels.

» More on the current account from William J. Polley
Here's a great article on the current account from the Cleveland Fed. Macroblog pulls out the thesis from the article itself: This Economic Commentary offers a hitchhiker’s guide to the U.S. current account problem for those who want to follow... [Read More]

Tracked on Jan 3, 2005 5:34:09 PM

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Of all the things in economics, national accounting confuses me the most. Here’s the question; if the world trades with only one currency are there still twin deficits and surpluses? And if they matter, why don't we measure inter-state deficits?

The only problems I can see in the discussion of current account issues are governments spending too much and central banks "mismanaging" monetary policy..
What am I missing?

Bad policy is not the only reason for a growing current account deficit. If the U.S. economy grows faster than other economies, our demand for imports will naturally outpace the demand for our exports. I think that has actually been at least part of the story over the past several years.

The "one currency" question is an interesting one. Of course, there is an analog to the current account surplus across states. I guess the reason we don't bother to measure them is that all states operate with identical capital markets, identical monetary policies, identical federal fiscal policies, very mobile factor markets, and the like. That pretty much takes many of the policy questions off the table, and means that the adjustment processes will naturally kick into gear.

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December 23, 2004

More On The Dollar, The Current Account, And Soft Landings

General Glut's Globblog (great name) indirectly takes on my argument -- made here and here -- that the reversal of the U.S. current account need not be as gut-wrenching as some fear. Actually he takes on what he refers to as Brad DeLong's "tepid endorsement" of my "soft landing" scenario. (In truth, I didn't really interpret DeLong's post as an endorsement, tepid or otherwise, but as a fair attempt to characterize an alternative view.) Here's the core of the General's complaint:

Thus far we have had nearly three years of [1] ("the dollar falls") and not a bit of [2] ("net exports rise"). From February 2002 to December 2004 the dollar has fallen 16% in real terms (per the broad dollar index) while the trade deficit has grown in real terms about 60%. I keep hearing the "delayed effects" mantra, but it's beginning to wear really thin for me.

The "delayed effects" mantra, of course, refers to what is sometimes called the "J-curve" effect -- the tendency for the current account to deteriorate upon a sustained depreciation of the currency, before it gets better. The idea is that export and import demand are relatively price-inelastic in the short run, so the main impact of a falling dollar is a rise in the exchange-adjusted price of imports.

I confess that I don't know the empirical literature well enough to speak to the issue of whether we are at the point where the J-curve explanation strains credulity. (Maybe someone can fill me in on this.) But I'm not inclined to lean on the "delayed effects" explanation in any event, not least because I suspect that the conditions that would yield significant J-curve dynamics would also work against the soft landing story.

Let me instead turn to the language I used in my previous post.

...the story I was telling was all about reversing the big capital inflows and trade deficits, one that starts with the presumption that foreigner's taste for absorbing ever more dollar-denominated assets has come to an end.

I've added the emphasis to make clear that I do not assume this process started three years ago when the dollar began to depreciate. In fact, I have interpreted some of the fall in the exchange rate in much more conventional terms: Because the U.S. economy had been expanding faster than its major trading partners, import demand has grown faster than export demand. In simple supply and demand terms, the greater desire for foreign goods by U.S. consumers and businesses means a greater supply of dollars, causing the dollar to fall in value relative to other currencies.

I realize that identifying a unique shock for every twist in the data can be the last refuge of a scoundrel. Skepticism is entirely warranted. But we should be equally wary of starting history at some arbitrary time, and then interpreting all subsequent dynamics as the consequence of whatever shock we have chosen as our initial condition. As usual, we'll each tell our stories, keep our eye out for some compelling evidence in favor of one or the other, and hope we can sort it out in the end.

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I'm not big on the J-curve literature, either, but the logic seems pretty clear. Three things, I think, need to be held in mind. One is that, as long as the dollar continues to fall, the short side of the J keeps working. The J-curve is in effect for the most recent decline in the dollar, just as it was for the initial decline from the high of 3 years ago. That would offset some of the current benefit from the long side of the J-curve. Another is that China is pegged to the dollar, so that we have received no benefit from relative price shifts vs China due to fx changes. Finally, oil demand tends to be rather inelastic in the short and medium term, and a good bit of the year-on-year rise in the trade deficit (46.7% as of the latest release in October) is due to petroleum. Now part of the rise in petroleum prices is obviously just a reflection of the falling value of the dollar, but limited opportunities for new domestic production in the short term means the J-curve for the oil account would be rather slow in turning around.

The benefit to the US trade balance from dollar weakness, in the end, has to do with prices and their impact on saving, spending and production decisions. We have been through a period in the US in which demand has been propped up by tax rebate and refund checks, as well as by the availability of funds through mortgage refinancing. Both have seemed to lower national savings, so working to offset the impact of fx changes on the trade balance. Those special factors encouraging spending have faded, so will no longer work to offset the impact of price changes across the border. That, however, seems to confirm you worry that adjustment won't be gentle. There is no current stimulus to household spending among US trading partners anything like the tax and refi cash we enjoyed, to take up the slack in demand.

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Today's Statistics

Americans spent and earned more money in November and durable goods orders rebounded, showing year-end strength in the U.S. economy. Jobless claims rose less than forecast last week, and December's consumer confidence reached an 11-month high.

"The basic message of all these reports today is that the economy is in line for solid, above-average growth,'' said Ken Mayland, the president of ClearView Economics LLC...

One report showed housing may provide less strength for the economy. New home sales fell 12 percent in November to a 1.125 million annual rate from an all-time high in October, the Commerce Department also said today. The percentage decline, while the steepest in more than a decade, in part reflected a 50,000 upward revision to October's results. The median price dropped to $206,300 from $224,700.

"The housing sector has probably peaked, but the level of activity is still extremely high and other sectors such as capital spending will pick up the slack,'' Mayland said. "That will provide the juice for continued above-average growth.''

Consumer confidence rose to 97.1 this month from 92.8 in November in the University of Michigan's final reading today. December's figure was the highest since January.

Laurence Meyer, a former Fed Governor, adds this prediction on what it all means for monetary policy:

Meyer predicted the Fed will raise the overnight bank lending rate from 2.25 percent now to 3.5 percent by the end of 2005 to curb inflation. Core inflation, excluding food and energy, may rise about 2.25 percent in the year ahead and the Fed may act faster if inflation reaches 2.5 percent, he said.

The Bloomberg link also includes a handy sound clip, for those who prefer to take their news aurally.

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